4.2 Subsidy Flashcards
What is a subsidy?
A money grant given to firms to reduce costs of production and to encourage an increase in output.
Why do governments issue subsidies?
There are several reasons for issuing subsidies:
1) To correct market failures
2) To improve affordability of essential goods and services
3) Protectionism
How can the government correct market failures and improve allocative efficiency?
The government can correct market failures and improve allocative efficiency by subsidising or providing merit/public goods (such as schools, hospitals, and transport infrastructure) where underproduction or a lack of supply exists. By doing so, the government can correct market failures, achieve socially optimum outcomes, and improve allocative efficiency.
How do subsidies improve affordability of essential goods?
Subsidies can improve affordability of essential goods and services, such as vaccinations, education, and healthcare, by reducing the costs of these goods and services for consumers. It can be argued that no one should be excluded from consuming such goods and services given the substantial private benefits, but also the external benefits of consumption. Thus subsidies, can increase the living standards of those on lower incomes while also increasing the third-party benefits to the rest of society and employers.
What is protectionism?
Protectionism is a policy of using subsidies to domestic producers to reduce the quantity of imports into a country and protect domestic producers from foreign competition.
How do subsidies promote protectionism?
Subsidies can promote protectionism by reducing the costs of production for domestic firms, which encourages them to produce a greater level of output, reducing the level of imports entering a country.
What is a subsidy and how does it affect supply and price?
A subsidy is a money grant given to producers which lowers their costs of production and encourages an increase in output. A subsidy shifts the supply curve in the market downwards from S1 to S1+sub, which reduces the price of the product from P1 to P2.
Subsidy Diagram Analysis
1) Supply Curve: Shifts downwards from S1 to S1+sub
2) Price & Quantity: Price decreases from P1 to P2 and quantity increases from Q1 to Q2
3) Producer Revenue: Increases from P1XQ10 to BCQ20
4) Government Cost: BCDP2
5) Consumer Savings: P1XYP2
6) Welfare Loss: CDX
How does the law of demand affect quantity demanded?
According to the law of demand, where a lower price encourages greater consumption, the quantity demanded increases from Q1 to Q2 as the price of the product decreases from P1 to P2.
How do consumers benefit from a subsidy?
Consumers benefit from the subsidy as they pay lower prices from P1 to P2, which increases their consumer surplus. They can now purchase Q1 units at a lower price, leading to savings of P1P2XY. Additionally, as quantity in the market increases from Q1 to Q2, consumers benefit from greater output and choice.
How does the passing on of the subsidy impact consumers?
Eval 1
Consumers may not fully benefit from the subsidy as not all of it is passed on to them. Producers may use the subsidy for reasons opposed to its intention, such as paying off debts, increasing salaries or dividends, or saving in a bank, which reduces the benefit of lower prices to the consumer.
How does the demand elasticity impact the subsidy benefit?
Eval 2
If the demand for the good or service is price inelastic, the majority of the subsidy will be passed on to the consumer via lower prices, benefiting them greatly. The opposite is true if demand is price elastic.
How can a subsidy on necessities benefit society?
Eval 3
If the good or service being subsidized is a necessity such as education and healthcare, lower prices could help affordability and improve equitable outcomes, reducing exclusion and improving living standards significantly.
How can the cost of financing a subsidy impact society?
Eval 4
Although there may be a short-term benefit to consumers in the form of lower prices, the cost of financing the subsidy may result in higher taxes in the long term, which can widen income inequality and harm the poor. Cuts may be made to important public services, or taxes may rise on the rich, reducing economic growth.
How do producers and workers benefit from a subsidy?
Producers and Workers.
Producers benefit from a subsidy by increasing their revenues and keeping the subsidy that is not passed on to the consumer. This can be used to pay off debts, increase salaries, save in a bank, or pay dividends to shareholders. The increase in quantity can be beneficial to workers, creating employment.
